After a decade of uncertainty for the fledgling seniors housing industry investors and lenders have begun to discover the virtues of this evolving multifamily sector. As the gold rush in the apartment business diminishes with only modest increases in supply forecasted for the coming year, and a several other real estate sectors will likely witness limited new construction in many markets, the hunt is on for viable, new investment options.

According to the Urban Land Institute's new publication Housing for Seniors: Developing Successful Projects: "Developing housing for elderly people will be a growth industry during the next two or three decades. Not only are people living longer, but the large baby boom generation is moving into the older age cohorts of the U.S. population. Over the next 35 years, the number of people aged 65 and older will more than double to 70 million."

The financial community has more than taken note of this new generation of seniors housing products. Significant investments have been made by a wide variety of financing sources including, but not limited to, commercial banks, financial services/credit corporations, pension funds and institutional investors.

As an example, Nomura Securities International, the largest international investment banking firm, has completed the financing on more than $1.2 billion in U.S. seniors housing transactions in the past two years. The asset securitization approach that they have used for other real estate products has been successfully adapted to the seniors housing and residential health care business. Wall Street has also jumped on the bandwagon with a flurry of recent IPOs in the congregate and assisted living arena with a market capitalization value in the aggregate at more than $260 million.

Service leads to success

The emerging confidence in this industry's based upon the enhanced realty that, after a turbulent five-year period ending in the early '90s, seniors housing is developing a more consistent track record of financial successes. The old real estate axiom - location, location, location - being enhanced in this business by the recognition that success will in large part be dictated by operations, operations, operations. Providing value-added services for senior consumers, who typically require affordable living accommodations and cost efficient supportive services, will be a significant component to success in all sectors of the seniors housing business. Supporting the growing investor interest in this business is a more comprehensive and reliable data base of financial and operating statistics that includes the annual survey conducted by Washington, D.C.-based American Seniors Housing Association (ASHA) in association with Coopers & Lybrand L.L.P. The State of Seniors Housing 1995 summarizes fiscal year 1994 data from a survey of 272 seniors housing developments, encomassing 46,000 independent living/congregate units, assisted living units and nursing home beds throughout the nation.

As a reflection of the improved status of supply and demand, the survey reveals that the median occupancy rate for the entire portfolio of seniors housing residences sampled was 95%, with living communities reporting overall occupancy levels of 97%. According to David Schless, ASHA executive director, "Occupancy problems that were experienced by many industry operators in the late-1980s and early-1990s have steadily dwindled. As an example, our 1993 industry survey found that the median seniors housing occupancy rate was 85%."

While it is possible that the increased occupancy in properties surveyed reflected a dearth of new seniors housing communities built in the early part of this decade, it is also likely a reflection of increased consumer awareness of seniors housing options and improved management and marketing expertise by more financially secure operations.

Assisted living is center stage

The ASHA-sponsored research report included a survey of 100 seniors housing executives which concluded that assisted living was taking center stage in the seniors housing business.

The three most frequently identified product types - stand-alone assisted living residences, Alzheimer's/special care facilities and congregate housing with assisted living - can all be categorized as service-driven seniors housing product types. Many seniors housing firms are also now looking beyond the walls of their residences and are providing a variety of services (such as respite care, adult day care and home health care) that benefit older adults and their families in the community at large. The reasons for providing services to "outside community residents" are to (1) generate increased referrals to the seniors development; (2) increase market share; and (3) generate additional revenues for the seniors venture.

The executive survey goes on to highlight the regions over the next five years with the greatest opportunity for new development in this industry. Leading the way is the Northeast (40%), followed the Southeast (25%), North Central 19%), South Central and West (8% each)

Assisted living, defined as developments designed for frail seniors who need assistance with the activities of daily living (i.e. bathing, dressing, eating, etc.) but who do not require continuous skilled nursing care, is booming. According to Alex. Brown & Sons Inc., the assisted living business is estimated to generate revenues of $7 billion to $10 billion with growth of 30% to 40% expected over the next decade. This dramatic rate of growth is anticipated as a result of the explosive population trend of individuals 85 and older; the need for assistance among this generally frail population sector; the supply/demand imbalance for skilled nursing facilities; the relatively low cost of assisted living as compared to an institutional environment; and the ability to generate substantial profits in this evolving business.

By the year 2010, the segment of the population 85 and older will reach 6.6 million individuals, a 100% increase over the 1990 figures. In the 1990s alone, the 85+ population will increase by 48% and the 65 and over senior market will increase by a mere 13%. As the population ages, greater demands for assistance with activities of daily living (ADL) increase dramatically. Overall, according to the Agency for Health Policy and Research, nearly 57% of the 85+ population requires a variety of ADL services which can be provided in a cost efficient, assisted living environment.

Skilled nursing supply restricted

Furthermore, the demand for skilled nursing facilities is anticipated to outpace the availability of beds due primarily to state licensure restrictions and lack of available capital for the construction of new skilled nursing beds. For example, 37 of 50 states have Certificate of Need (CON) regulations that restrict nursing home construction. The remaining states generally require a CON for the expansion of services. This imbalance of supply/demand will be exacerbated in the future as the assisted living models provide a non-institutional environment for the frail elderly population.

In contrast to the skilled nursing business, assisted living owner/operators currently function in a relatively limited regulatory environment - although this situation is beginning to change.

Recent industry research further reveals that the costs associated with the assisted living alternative compare favorably to nursing facilities. Whereas the average semi-private daily charge for an assisted living residence is $50-$70, the semi-private cost for skilled nursing is typically 80-$l 10 per day. Accordingly, the assisted living sector of the seniors housing business should grow dramatically as an affordable option for managed care and government funding programs who are seeking to control the rapid growth in health care expenditures.

But is it profitable?

At the "end of the day," the question is whether one can make a profit in the service-intensive assisted living business. Given the current restraints on government regulation, the fact that this industry segment is almost entirely 100% private pay and the overall building areas are typically designed more efficiently than other seniors housing product types, profits can be attractive. Operating margins, once these properties reach stabilized occupancy levels, can range from 35% to 50%. However, as is the case with all seniors housing products, a caring management philosophy with a bottom line orientation is necessary for long-term financial success in this business.

As developers and investors consider their options in the assisted living, congregate and continuing care business, there are several factors which should be recognized as potential impediments. For example, in the assisted living sector, the general lack of government regulations may ultimately prove problematic for unwary owner/operators. As financing becomes increasingly available and marginal operators attempt to enter the business, the end result in certain markets could be decreased occupancy levels and resultant lower profit margins. It is likely that regulators will seize the opportunity to impose more stringent guidelines on assisted living developments and/or operating standards. In anticipation of this eventuality, the industry associations are proactively attempting to encourage reasonable regulatory approaches which emphasize consumer protection while safeguarding owner and investor interests.

A further concern of seniors housing industry leaders is the possibility that the availability of debt and equity financing could result in an oversupply of assisted living projects in select markets. This situation, if unchecked by financing sources, might result in market saturation within the coming two to three years. Accordingly, stringent underwriting standards based upon realistic fill-up and operating cost assumptions are essential for new developments.

Uncertainties related to the near-term national economic outlook combined with lackluster consumer confidence levels as reported by the National Conference Board are signals for cautious investing in the seniors housing business. A growing number of economists are warning of a growing threat of recession. At a minimum, economic growth through most of this year will be slow. The economic expansion that began in 1991 will be five years old this month. All signs point to precise business strategies in the seniors housing business.

Managed care is a factor

Managed care will also represent an important concept to understand for seniors housing owners and investors. The variety of health care options available to America's senior population could have a direct impact on this industry.

Managed care is a payment mechanism health insurers use to lock in on capitating their cost to provide care to health maintenance organization (HMO) and preferred provider organization (PPO) enrollees. By entering agreements with providers to deliver care to enrollees for a predetermined rate, HMOs are able to shift the risk for cost overruns to providers. In essence, service providers under managed care are betting they can deliver the necessary services to enrollees for costs that are equal to or below the predetermined rates negotiated with the HMO.

This is where the term "atrisk" comes into play in managed care. According to Jim Bowe, vice president of ASHA: "Think of managed care in terms of the food chain. The HMO is at the top of the food chain and fixes its costs by contracting with an organization further down the food chain, thereby passing on the risk of cost over-runs to this smaller organization that has agreed to deliver services for a flat fee. If the smaller organization can deliver care at a cost below the predetermined fee, it keeps the difference as profit. If it incurs unexpected cost overruns in delivering services, it absorbs the expense and loses money."

Managed care is rapidly penetrating the ranks of the elderly. About 9% of the elderly presently covered under Medicare have opted for HMO coverage. If the proposals now under consideration in Washington to overhaul Medicare by emphasizing lower cost managed care are enacted - and all indications today are that they will be - then projections indicate that as many as 40% of all Medicare beneficiaries will opt for HMOs within the next five years. Furthermore, retirees are increasingly participating in HMO plans sponsored by their former employers. Accordingly, as time goes on, more and more members of the target market for seniors housing will be enrolled in HMOs.

According to Bowe, "in this rapidly evolving managed care environment, congregate, assisted living and continuing care retirement communities will become increasingly vulnerable to potential losses."

Congregate operators will face stiff competition from home health care operators. Given the choice between selling their houses and moving to a rental retirement community in order to access amenities and support services, or staying in their houses and receiving at no additional cost an array of Medicare-covered, community-based services through their HMO, many seniors will choose the latter. Medicare HMOs feature additional benefits that typically are not covered under the traditional Medicare fee-for-service plan. Medicare HMOs use this broader array of benefits to increase their market share.

For assisted living owners and investors, their developments will not only be competing with HMO home care and community-based services, but they also will face HMO providers of nursing, therapies and other health care services coming into their buildings to serve residents enrolled in managed care. Opportunities for assisted living operators to deliver profitable ancillary services could well be lost as a host of outsiders invade the premises to deliver care.

Continuing care retirement communities (CCRC) are already grappling with the influence of managed care. In addition to the issues facing both congregate and assisted living residences, CCRCs have other significant concerns. In California and Florida, in particular, where many seniors are already enrolled in Medicare HMOs, residents following discharge from hospitals can be transferred to skilled nursing beds outside the CCRC. This obviously undermines the entire premise of providing all necessary long-term care on campus to CCRC residents.

Creative opportunities exist

If creatively handled, there are a variety of opportunities for seniors housing owners/operators to participate in a managed care network.

As strategic alliances gain more prominence in the delivery of care under capitation, seniors housing providers have the opportunity to participate in managed care partnerships and alliances. Seniors housing operators typically will not have a high enough concentration of HMO enrollees residing in their properties within a specific geographic area to contract directly with an HMO. However, health care providers who contract directly with HMOs or subcontract with other organizations participating in managed care will have incentives to reach HMO enrollees residing in seniors housing developments.

For example, a home care company or a health care provider may have a managed care contract and be anxious to enter an agreement with a seniors housing owner/operator to access its HMO residents. Or a nursing home or hospital may enter a shared risk agreement with a seniors housing operator. This would allow the health care facility to transfer a rehabilitating resident to the less expensive seniors housing site for further recovery. The health care facility and housing operator under this scenario would split a predetermined percentage of the flat rate paid by the HMO for caring for the enrollee. If a seniors housing owner/operator successfully launches its own home care agency or another health care business, it may be able to market its services in the surrounding community and compete for HMO contracts to provide community-based care and services.

Success in the seniors housing business, whether as a developer or investor in and independent living/congregate, continuing care or assisted living community, will require a broad knowledge of the unique business principals of this industry. Providing a vertically integrated network of housing and service programs so residents can "age in place" will be critical to enhanced occupancy levels and favorable financial results.

* 6.6 million people will be 85 or older by the year 2010, a 100% increase over 1990 figures.

* The 85+ population will increase by 48% during the 1990s.

* The 65+ population will increase by 13% during the 1990s.

* Nearly 57% of the 85+ population requires ADL services.

* Over the next 35 years, the number of people 65 and older will more than double to 70 million.

% favoring Region region Northeast40% Southeast25% North Central 19% South Central 8% West8% Source: American Seniors Housing Association

Regulatory Environment

Assisted Living Currently relatively limited. Skilled Nursing37 of 50 states have Certificate of Need

regulations restricting nursing home construction;

the rest generally require a

CON for expansion of services.

Average Semi-private Charge

Assisted Living $50 - $70 per day Skilled Nursing $80 - 110 per day

Outlook for Growth of Sector

Assisted LivingShould grow dramatically as affordable

option for managed care and government

funding programs; could result in oversupply

in some markets. Skilled NursingDemand will outpace beds due to state licensure

restrictions and lack of available

capital for new construction.

President Clinton has signed into law a bill making it easier for some elderly housing projects to qualify for an exemption from the ban on discrimination against families with children.

The Fair Housing generally prohibits discrimination in housing on the basis of familial status, but provides an exemption for elderly housing projects, including housing intended for occupancy by persons 55 and over.

Originally, 55-and-over housing qualified for the exemption only if it included "significant facilities and services" for elderly persons. The bill signed by Clinton drops the "significant facilities and services" requirement. Instead, 55-and-over housing will qualify for the exemption if at least 80% of the units are occupied by at least one person 55 or older, the housing project or community publishes and follows policies and procedures showing the intent to restrict occupancy and the project or community complies with HUD regulations on the verification of 55-and-over occupancy.

Bond refunding totaling $50.45 million has been structured using Fannie Mae credit enhancements for Angelus Plaza, a 1,093-unit, five-building complex in downtown Los Angeles, by Washington Mortgage Financial Group, Vienna, Va. Managed by Retirement Housing Foundation of Long Beach, Calif., the complex, which ranks as the nation's largest affordable senior housing community, is 100% occupied and has a waiting list of over 1,000.

The first piece of the refunding included $33.02 million in tax-exampt bonds and $1.85 million in taxable bonds. It covers the first phase of Angelus Plaza, which consists of three high-rise apartment buildings totaling 761 units and a six-story activities center that were constructed in 1980. The second part of the refunding covers the second phase of the project, a 332-unit high-rise completed in 1982. This transaction included $15.47 million in new tax-exampt bonds and $300,000 in taxable bonds.

Both phases originally were financed with tax-exampt bonds issued by the Community Redevelopment Agency of Los Angeles. The property also benefits from two Section 8 contracts covering 100% of the units. The Fannie Mae collateral pledge guarantee was overlayed on both pahses to permit McKinney Act refinancing.

Mel Gamzon is president of Senior Housing Investment Advisors Inc., a Newton, Mass.-based investment consulting and real estate brokerage firm that specializes in the seniors housing industry nationwide. The firm is affiliated with New America Network, Hightstown, N.J.